Deciding on Executive Pay: Lack of Independence Is Seen

By DIANA B. HENRIQUES and GERALDINE FABRIKANT

Published: December 18, 2002

When America's biggest companies decide how much to pay their top executives, most of them leave the decision to a group of their board members known as the compensation committee. In theory, members of this committee are independent enough of the company's executives to deny them raises or force them to take pay cuts when the company is faring poorly.

In practice, it can be a very different story. An examination of almost 2,000 corporations finds that at hundreds of them, members of the compensation committee work for or do business with the company or its chief executive. In some cases, they even belong to the executive's family.

Legislation enacted this summer after a wave of costly corporate scandals is silent about the makeup of the compensation committee, although the new law set high standards of independence for another important boardroom committee, the audit committee, which oversees a company's financial controls and the auditing of its books.

Yet compensation committees are "definitely more clubby" than they should be, said Roger W. Raber, chief executive of the National Association of Corporate Directors, which thinks that only board members with no personal or business ties to the company should serve on its compensation committee. "They just don't have the rigor of oversight that we see with other committees, especially audit committees."

Mr. Raber added: "That, to me, is going to be the continuing crisis: looking at some of the pay practices, especially the severance packages. We have another storm to go through, and frankly, it's going to be ugly."

The study by The New York Times of almost 2,000 of the largest American corporations, measured by their stock market value, shows that 420 of them, more than 20 percent, had compensation committees in 2001 with members who had business ties or other relationships with the chief executive or the company that could compromise their independence. Dozens of those members were company executives.

At more than 70 companies, even the chairman of the compensation committee had such ties, and in nine cases the chairman was actually an executive of the company.

These are just the connections that have been fully disclosed to investors.

That such ties are not always disclosed was illustrated yesterday, when Frank E. Walsh Jr., a former member of the compensation committee at Tyco International , pleaded guilty to charges of failing to report that Tyco had paid him a $20 million fee for his role in a company deal.

Potential conflicts of interest cropped up at some of the nation's best-known companies.

For example, at Clear Channel Communications , the nation's largest radio chain, only one of the five people on its compensation committee is free of potential conflicts. The committee has retained — indeed, sweetened — pay packages that guaranteed raises for the chairman, L. Lowry Mays, and his two sons, regardless of company performance. The sons have severance agreements that entitle them to 14 years of salary, bonuses, benefits and stock options if they quit because the board fails to choose one of them to succeed their father as chief executive. Clear Channel said the committee met existing federal guidelines for independence.

At the Great Atlantic and Pacific Tea Company , which owns the Waldbaum's, Food Emporium and A.& P. supermarket chains, only one of the three people on the compensation committee is independent. A second is the family lawyer for the 38-year-old chief executive, Christian W. E. Haub, and a third works for Mr. Haub's parents, the company's controlling shareholders. The committee has regularly approved raises and larger bonuses for Mr. Haub, despite the company's worsening business problems. The company said it was considering revising the committee's composition, but said the pay was appropriate.

And three of the eight people who set the final pay package for John F. Welch Jr. when he was chief executive of General Electric have done business, through their own companies, with G.E. Their decision, which at first looked like a pay cut for Mr. Welch, actually gave him a 50 percent raise for the year. That raise substantially improved Mr. Welch's pension after he retired in early September 2001. The company declined to comment on the arrangement, although it has subsequently taken steps to increase the independence of its board.

These cases and others cited here are based on an analysis by The New York Times of a database compiled by the Corporate Library, an investor information service; on the most recently available corporate proxy statements, in most cases those filed this year for the 2001 fiscal year; and on interviews with compensation experts and securities lawyers. The database defines directors as independent unless they have family, business or professional ties to the company or are owners or beneficiaries of some other entity that profits directly from the company's activities, like a law firm or major supplier.